Every now and again, an article about hedge funds appears that is so bad it’s good. This one by Gregory Meyer, a markets reporter at the FT is one of those. By twisting a reasonable quote to mean something completely different, he diverts attention away from what cartels do, and ignores the risk of collusion.
With a headline “Opec says hedge funds lack ‘basic understanding’ of oil”, Mr Meyer goes on to report that “Hedge funds are important players in the oil market, but some do not comprehend how it works, a senior Opec official has said.” And Meyer goes on to quote Mohammed Barkindo directly: “Several [fund managers] had little or no experience or even a basic understanding of how the physical oil market works,”
I’m not going to blame Mr Meyer for the misleading headline, because he probably didn’t write it. But I will for the misleading lead. Let’s look at it for a second. The original quote referred to several hedge fund or money managers who didn’t understand how the physical oil market works. But Mr Meyer’s lead transforms “several” to “some”, while removing the qualification about the “physical” oil market and implying the comments were only about hedge fund managers. And the headline writer has transformed “some” to all hedge funds lacking understanding about anything to do with oil, by removing the final qualification.
But what’s the real story here? Is Mohammed Barkindo, Opec’s secretary-general, wrong about several fund managers not having a basic understanding of the physical oil market? No. Even if he knew which ones were which and was talking solely about hedge funds, he would probably have been right. But it’s not really news. Here’s why:
- There are probably 10,000 to 15,000 hedge funds in existence. Most of them do not invest in the oil market at all, because it is not their focus or expertise.
- Some managers may decide to learn about the oil market by looking into it. This could be because they are considering investing directly, or because they are interested in its potential impact on other markets.
- Some managers may have sent their junior staff to the meeting with Mr Barkindo, while they stayed in the office and worked.
- Hedge funds do not take delivery of physical oil. This is by choice and design.
- Some managers deliberately distance themselves from the fundamentals or subjective aspects of a market, preferring to look for systematic pricing anomalies that Mr Barkindo would not be able to observe. The history of commodities trading is such that traders provide liquidity to the market, by observing and trading on price patterns that may be caused by irrational behaviour of the physical market. This can cause prices to be smoothed across varying demand and supply cycles, as well as the usual demon of short to medium term momentum-based price movements.
But also, you have to look at the context of Mr Meyer’s article. Opec is, as he rightly points out, a cartel. That means Opec seeks to manipulate the price of oil to maximise the oil revenue of the member countries. It does this principally by adjusting oil output in the context of demand. Where I come from, cartels which successfully manipulate prices are bad for consumers, because prices get inflated in the short, medium and long term.
Hedge funds, especially in the long term, really don’t care whether prices are going up or down. They are more interested in profiting from identifying when for whatever reason, a price is wrong, but they expect it to revert to the right price. As you can probably see, hedge funds and cartels are strange bedfellows. A cartel is likely to be very unhappy if hedge funds stymie its manipulation activities by selling oil, but very happy when hedge funds buy oil. Meanwhile hedge funds (not all, but some smart ones) adore making money from predictable price manipulation by cartels.
This takes me to another fascinating part of the article: Mr Meyer says that the oil supply is “regulated by Opec”. This is not a word I would use. Possibly more suitable ways of putting it would be that the oil supply is “controlled” or “manipulated” by Opec. The word ‘regulated” implies Opec is a benevolent regulator, acting in the interests of consumers, for their protection. That is not what cartels do.
In Mr Barkindo’s defence, not only is he probably correct in his assessment of the representatives of several fund managers, but his comments could possibly have been more fairly framed. He stated that he learned something from some of them about the complexity of financial markets, but that some of the fund managers probably learned something about the physical markets. Not so newsworthy or surprising, when you look at it like that.
For me, the real story is in considering the risks arising from meetings between Opec and fund managers who move markets by virtue of their trading size or reputation. Despite Mr Barkindo’s assertion that there is no discussion of prices or production cuts in his meetings, we must be wary about the opportunity for collusion that arises. For example, when a fund manager thinks he has a hint or clue that a production change is about to happen, he might trade to take advantage of it. Fund managers would be very well advised to avoid one-on-one discussions with Opec, in order to avoid any suggestion of impropriety.
Overall, I can’t help thinking the FT’s reporter, Gregory Meyer lacks basic understanding, or even curiosity of how hedge funds work. But reading between the lines here is far more interesting than the article itself.